01. The objective of this Standard is to prescribe the accounting policies and procedures in relation to relevant elements and the recognition of these elements in the financial statements of an insurance company, including

a) The method of accounting for insurance contracts in insurance companies;

b) Presentation and explanation of data in the financial statements of an insurance company resulting from an incurrence contract.

02. An entity shall apply this Standard to:

(a) Insurance contracts (including reinsurance contracts) that it issues and reinsurance contracts that it holds.

(b) Financial instruments under insurance contracts that it issues with a discretionary participation feature

03. This Standard does not address other aspects of accounting by insurers, such as accounting for financial assets held by insurers and financial liabilities issued by insurers which do not relate to insurance contracts.

(c) Contractual rights or contractual obligations that are contingent on the future use of, or right to use, a non-financial item (for example, some licence fees, royalties, contingent lease payments and similar items), as well as a lessee’s residual value guarantee embedded in a finance lease (see VAS 06 Leases, VAS 14 Revenue and Other Incomes and VAS 04 Intangible Fixed Assets).

(d) Financial guarantees that an entity enters into or retains on transferring to another party financial assets or financial liabilities within the scope of VAS on Financial Instruments regardless of whether the financial guarantees are described as financial guarantees or letters of credits.

(e) Contingent consideration payable or receivable in a business combination (see VAS 11 Business Combinations).

(f) Direct insurance contracts in which the entity is the policyholder.

05. The following terms are used in this Standard with the meanings specified:

Insurer: The party that has an obligation under an insurance contract to compensate a policyholder if an insured event occurs.

Insurance contract: A contract under which the insurer agrees to a certain amount (ie insurance fee) accepts significant insurance risk from a customer (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event adversely affects the policyholder.

Direct insurance contract: An insurance contract that is not a reinsurance contract.

Policyholder: A party that has a right to compensation under an insurance contract if an insured event occurs.

Reinsurance contract: An insurance contract issued by the reinsurer to compensate the cedant for losses on one or more contracts issued by the cedant.

The policyholder under a reinsurance contract: A direct insurance company which transfers risk under a reinsurance contract.

Insurance risk: Risk, other than financial risk, transferred from the holder of a contract to the insurer.

Deposit component: A contractual component that is not accounted for as a derivative under standard on Financial Instruments and would be within the scope of standard on Financial Instruments if it were a separate instrument.

Guaranteed element: An obligation to pay guaranteed benefits, included in a contract.

Guaranteed benefits: Payments or other benefits to which a particular policyholder or investor has an unconditional right that is not subject to the contractual discretion of the insurer.

Discretionary participation feature: A contractual right to receive, as a supplement to guaranteed benefits, additional benefits:

(a) that is likely to be a significant portion of the total contractual benefits;

(b) Whose amount or timing is contractually at the discretion of the insurer; and

(c) that is contractually based on:

(i) The performance of a specified pool of contracts or a specified type of contract;

(ii) Realised and/or unrealised investment returns on a specified pool of assets held by the insurer; or

(iii) The profit or loss of the company, fund or other entity that issues the contract.

Unbundle: Account for the components of a contract as if they were separate contracts.

Fair value: The amount for which an asset could be exchanged or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.

Financial risk: The risk of a possible future change in one or more of a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract.

Financial instrument: Any contract in which one contracting party (an enterprise) creates a financial asset and the other party incurs a corresponding financial liability or an equity instrument.

A derivative: A financial instrument whose value changes in response to the change in an underlying unit that requires no initial net investment or little initial net investment relative to the other type of contracts and is settled at a future date.

Insured event: An uncertain future event that is covered by an insurance contract and creates insurance risk.

Liability adequacy test: An assessment of whether the carrying amount of an insurance liability needs to be increased (or the carrying amount of related deferred acquisition costs or related intangible assets decreased), based on a review of future cash flows.

CONTENT OF THE STANDARD

Embedded derivatives

06. The standard on Financial Instruments requires an entity to separate some embedded derivatives from their host contract, measure them at fair value and include changes in their fair value in profit or loss. Standard on Financial Instruments applies to derivatives embedded in an insurance contract unless the embedded derivative is itself an insurance contract.

07. As an exception to the requirement in standard on Financial Instruments, an insurer need not separate, and measure at fair value, a policyholder’s option to surrender an insurance contract for a fixed amount (or for an amount based on a fixed amount and an interest rate), even if the exercise price differs from the carrying amount of the host insurance liability. However, the requirement in standard on Financial Instruments does apply to a put option or cash surrender option embedded in an insurance contract if the surrender value varies in response to the change in a financial variable (such as an equity or commodity price or index), or a nonfinancial variable that is not specific to a party to the contract. Furthermore, that requirement also applies if the holder’s ability to exercise a put option or cash surrender option is triggered by a change in such a variable (for example, a put option that can be exercised if a stock market index reaches a specified level).

09. Some insurance contracts contain both an insurance component and a deposit component. In some cases, an insurer is required or permitted to unbundle those components:

(a) Unbundling is required if both the following conditions are met:

(i) The insurer can measure the deposit component (including any embedded surrender options) separately (ie without considering the insurance component).

(ii) The insurer’s accounting policies do not otherwise require it to recognise all obligations and rights arising from the deposit component as shown in paragraph 10 as an example.

(b) Unbundling is permitted, but not required, if the insurer can measure the deposit component separately as in (a)(i) but its accounting policies require it to recognise all obligations and rights arising from the deposit component, regardless of the basis used to measure those rights and obligations.

(c) Unbundling is prohibited if an insurer cannot measure the deposit component separately as in (a)(i).

10. The following is an example of a case when an insurer’s accounting policies do not require it to recognise all obligations arising from a deposit component. A cedant receives compensation for losses from a reinsurer, but the contract obliges the cedant to repay the compensation in future years. That obligation arises from a deposit component. If the cedant’s accounting policies would otherwise permit it to recognise the compensation as income without recognising the resulting obligation, unbundling is required.

11. To unbundled a contract, an insurer shall:

(a) Apply this Standard to the insurance component.

(b) Apply standard on Financial Instruments to the deposit component.

Recognition and Measurement

Accounting application

12. An insurer:

(a) Shall not recognize as a liability any provisions for possible future claims, if those claims arise under insurance contracts that are not in existence at the reporting date (such as catastrophe provisions and equalisation provisions).

(b) Shall carry out the liability adequacy test described in paragraphs 13-17.

(c) Shall remove an insurance liability (or a part of an insurance liability) from its balance sheet when, and only when, it is extinguished.

(d) Shall not offset:

(i) Reinsurance assets against the related insurance liabilities; or

(ii) Income or expense from reinsurance contracts against the expense or income from the related insurance contracts.

13. An insurer shall assess at each reporting date whether its recognised insurance liabilities are adequate, using current estimates of future cash flows under its insurance contracts. If that assessment shows that the carrying amount of its insurance liabilities (less related deferred acquisition costs and related intangible assets, such as those discussed in paragraphs 27 and 28) is inadequate in the light of the estimated future cash flows, the entire deficiency shall be recognised in profit or loss.

(a) The test considers current estimates of all contractual cash flows, and of related cash flows such as claims handling costs, as well as cash flows resulting from embedded options and guarantees.

(b) If the test shows that the liability is inadequate, the entire deficiency is recognised in profit or loss.

In presenting profit and loss to the insurance administration (the Ministry of Finance), insurers shall follow all financial guidelines and regulations on exploitation costs.

15. If an insurer’s accounting policies do not require a liability adequacy test that meets the minimum requirements of paragraph 14, the insurer shall:

(a) Determine the carrying amount of the relevant insurance liabilities less the carrying amount of:

(i) Any related deferred acquisition costs; and

(ii) Any related intangible assets, such as those acquired in a business combination or portfolio transfer (see paragraphs 27 and 28). However, related reinsurance assets are not considered because an insurer accounts for them separately (see paragraph 18).

(b) Determine whether the amount described in (a) is less than the carrying amount that would be required if the relevant insurance liabilities were within the scope of VAS 18, Provisions, Contingent Liabilities and Contingent Assets. If it is less, the insurer shall recognise the entire difference in profit or loss and decrease the carrying amount of the related deferred acquisition costs or related intangible assets or increase the carrying amount of the relevant insurance liabilities.

16. If an insurer’s liability adequacy test meets the minimum requirements of paragraph 14, the test is applied at the level of aggregation specified in that test. If its liability adequacy test does not meet those minimum requirements, the comparison described in paragraph 15 shall be made at the level of a portfolio of contracts that are subject to broadly similar risks and managed together as a single portfolio.

17. The amount described in paragraph 15(b) (ie the result of applying VAS 18 Provisions, Contingent Liabilities and Contingent Assets) shall reflect future investment margins (see paragraphs 24-26) if, and only if, the amount described in paragraph 15(a) also reflects those margins.

Impairment of reinsurance assets

18. If a cedant’s reinsurance asset is impaired, the cedant shall reduce its carrying amount accordingly and recognise that impairment loss in profit or loss. A reinsurance asset is impaired if, and only if:

(a) There is objective evidence, as a result of an event that occurred after initial recognition of the reinsurance asset, that the cedant may not receive all amounts due to it under the terms of the contract; and

(b) That event has a reliably measurable impact on the amounts that the cedant will receive from the reinsurer.

Changes in accounting policies

19. An insurer may change its accounting policies for insurance contracts if, and only if, the change makes the financial statements more relevant to the economic decision-making needs of users and no less reliable, or more reliable and no less relevant to those needs. An insurer shall judge relevance and reliability by the criteria in VAS 29 Changes in Accounting Policies, Accounting Estimates and Errors.

20. To justify changing its accounting policies for insurance contracts, an insurer shall show that the change brings its financial statements closer to meeting the criteria in VAS 29, but the change need not achieve full compliance with those criteria. The following specific issues are discussed below:

(a) Current interest rates (paragraph 21);

(b) Continuation of existing practices (paragraph 22);

(c) Prudence (paragraph 23);

(d) Future investment margins (paragraphs 24-26);

Current market interest rates

21. An insurer is permitted, but not required, to change its accounting policies so that it remeasures designated insurance liabilities to reflect current market interest rates and recognises changes in those liabilities in profit or loss. At that time, it may also introduce accounting policies that require other current estimates and assumptions for the designated liabilities. The election in this paragraph permits an insurer to change its accounting policies for designated liabilities, without applying those policies consistently to all similar liabilities as VAS 29 would otherwise require. If an insurer designates liabilities for this election, it shall continue to apply current market interest rates (and, if applicable, the other current estimates and assumptions) consistently in all periods to all these liabilities until they are extinguished.

Continuation of existing practices

22. An insurer may continue the following practices, but the introduction of any of them does not satisfy paragraph 19:

(a) Measuring insurance liabilities on an undiscounted basis.

(b) Measuring contractual rights to future investment management fees at an amount that exceeds their fair value as implied by a comparison with current fees charged by other market participants for similar services. It is likely that the fair value at inception of those contractual rights equals the origination costs paid, unless future investment management fees and related costs are out of line with market comparables.

(c) Using non-uniform accounting policies for the insurance contracts (and related deferred acquisition costs and related intangible assets, if any) of subsidiaries, except as permitted by paragraph 21. If those accounting policies are not uniform, an insurer may change them if the change does not make the accounting policies more diverse and also satisfies the other requirements in this Standard.

Prudence

23. Applying prudence as a principle, an insurer need not change its accounting policies for insurance contracts to eliminate excessive prudence. However, if an insurer already measures its insurance contracts with sufficient prudence, it shall not introduce additional prudence.

Future investment margins

24. An insurer need not change its accounting policies for insurance contracts to eliminate future investment margins. However, there is a rebuttable presumption that an insurer’s financial statements will become less relevant and reliable if it introduces an accounting policy that reflects future investment margins in the measurement of insurance contracts, unless those margins affect the contractual payments.

Two examples of accounting policies that reflect those margins are:

(a) Using a discount rate that reflects the estimated return on the insurer’s assets; or

(b) Projecting the returns on those assets at an estimated rate of return, discounting those projected returns at a different rate and including the result in the measurement of the liability.

25. An insurer may overcome the rebuttable presumption described in paragraph 24 if, and only if, the other components of a change in accounting policies increase the relevance and reliability of its financial statements sufficiently to outweigh the decrease in relevance and reliability caused by the inclusion of future investment margins.

For example, suppose that an insurer’s existing accounting policies for insurance contracts involve excessively prudent assumptions set at inception and a discount rate prescribed by a regulator without direct reference to market conditions, and ignore some embedded options and guarantees. The insurer might make its financial statements more relevant and no less reliable by switching to a comprehensive investor-oriented basis of accounting that is widely used and involves:

(a) Current estimates and assumptions;

(b) A reasonable (but not excessively prudent) adjustment to reflect risk and uncertainty;

(c) Measurements that reflect both the intrinsic value and time value of embedded options and guarantees; and

(d) A current market discount rate, even if that discount rate reflects the estimated return on the insurer’s assets.

26. In some measurement approaches, the discount rate is used to determine the present value of a future profit margin. That profit margin is then attributed to different periods using a formula. In those approaches, the discount rate affects the measurement of the liability only indirectly. In particular, the use of a less appropriate discount rate has a limited or no effect on the measurement of the liability at inception. However, in other approaches, the discount rate determines the measurement of the liability directly. In the latter case, because the introduction of an asset-based discount rate has a more significant effect, it is highly unlikely that an insurer could overcome the rebuttable presumption described in paragraph 24.

Insurance contracts acquired in a business combination or portfolio transfer

27. To comply with VAS 11 Business Combinations, an insurer shall, at the acquisition date, measure at fair value the insurance liabilities assumed and insurance assets acquired in a business combination. However, an insurer is permitted, but not required, to use an expanded presentation that splits the fair value of acquired insurance contracts into two components:

(a) A liability measured in accordance with the insurer’s accounting policies for insurance contracts that it issues; and

(b) An intangible asset, representing the difference between

(i) The fair value of the contractual insurance rights acquired and insurance obligations assumed; and

(ii) The amount described in (a).

The subsequent measurement of this asset shall be consistent with the measurement of the related insurance liability.

28. An insurer acquiring a portfolio of insurance contracts may use the expanded presentation described in paragraph 27.

29. The intangible assets described in paragraphs 27 and 28 are excluded from the scope of VAS on Impairment of Assets and VAS on Intangible Fixed Assets. However, these VASs apply to customer lists and customer relationships reflecting the expectation of future contracts that are not part of the contractual insurance rights and contractual insurance obligations that existed at the date of a business combination or portfolio transfer.

30. Some insurance contracts contain a discretionary participation feature as well as a guaranteed element. The insurer of such a contract:

(a) May, but need not, recognise the guaranteed element separately from the discretionary participation feature. If the insurer does not recognise them separately, it shall classify the whole contract as a liability. If the insurer classifies them separately, it shall classify the guaranteed element as a liability.

(b) Shall, if it recognises the discretionary participation feature separately from the guaranteed element, classify that feature as either a liability or a separate component of equity. This Standard does not specify how the insurer determines whether that feature is a liability or equity. The insurer may split that feature into liability and equity components and shall use a consistent accounting policy for that split. The insurer shall not classify that feature as an intermediate category that is neither liability nor equity.

(c) May recognise all premiums received as revenue without separating any portion that relates to the equity component. The resulting changes in the guaranteed element and in the portion of the discretionary participation feature classified as a liability shall be recognised in profit or loss. If part or the entire discretionary participation feature is classified in equity, a portion of profit or loss may be attributable to that feature (in the same way that a portion may be attributable to minority interests). The insurer shall recognise the portion of profit or loss attributable to any equity component of a discretionary participation feature as an allocation of profit or loss, not as expense or income (see VAS 21 Presentation of Financial Statements).

(d) Shall, if the contract contains an embedded derivative, apply VAS on Financial Instruments to that embedded derivative.

(e) Shall, in all respects not described in paragraphs 12-18 and 30(a)-(d), continue its existing accounting policies for such contracts, unless it changes those accounting policies in a way that complies with paragraphs 19-26.

Discretionary participation features in financial instruments

31. The requirements in paragraph 30 also apply to a financial instrument that contains a discretionary participation feature. In addition:

(a) If the insurer classifies the entire discretionary participation feature as a liability, it shall apply the liability adequacy test in paragraphs 14-17 to the whole contract (ie both the guaranteed element and the discretionary participation feature). The insurer need not determine the amount that would result from applying VAS on Financial Instruments to the guaranteed element.

(b) If the insurer classifies part or that entire feature as a separate component of equity, the liability recognised for the whole contract shall not be less than the amount that would result from applying VAS on Financial Instruments to the guaranteed element. That amount shall include the intrinsic value of an option to surrender the contract, but need not include its time value if paragraph 08 exempts that option from measurement at fair value. The insurer need not disclose the amount that would result from applying VAS on Financial Instruments to the guaranteed element, nor need it present that amount separately. Furthermore, the insurer need not determine that amount if the total liability recognised is clearly higher.

(c) Although these contracts are financial instruments, the insurer may continue to recognise the premiums for those contracts as revenue and recognise as an expense the resulting increase in the carrying amount of the liability.

Disclosure

Explanation of recognised amounts

32. An insurer shall disclose information that identifies and explains the amounts in its financial statements arising

from insurance contracts.

33. To comply with paragraph 32, an insurer shall disclose:

(a) Its accounting policies for insurance contracts and related assets, liabilities, income and expense.

(b) The recognised assets, liabilities, income and expense (and, if it presents its cash flow statement using the direct method, cash flows) arising from insurance contracts. Furthermore, if the insurer is a cedant, it shall disclose:

(i) Gains and losses recognised in profit or loss on buying reinsurance; and

(ii) if the cedant defers and amortises gains and losses arising on buying reinsurance, the amortisation for the period and the amounts remaining unamortised at the beginning and end of the period.

(c) The process used to determine the assumptions that have the greatest effect on the measurement of the recognised amounts described in (b). When practicable, an insurer shall also give quantified disclosure of those assumptions.

(d) The effect of changes in assumptions used to measure insurance assets and insurance liabilities, showing separately the effect of each change that has a material effect on the financial statements.

34. An insurer shall disclose information that helps users to understand the amount, timing and uncertainty of future

cash flows from insurance contracts.

35. To comply with paragraph 34, an insurer shall disclose:

(a) Its objectives in managing risks arising from insurance contracts and its policies for mitigating those risks.

(b) Those terms and conditions of insurance contracts that have a material effect on the amount, timing and uncertainty of the insurer’s future cash flows.

(c) Information about insurance risk (both before and after risk mitigation by reinsurance), including information about:

(i) The sensitivity of profit or loss and equity to changes in variables that have a material effect on them.

(ii) Concentrations of insurance risk.

(iii) Actual claims compared with previous estimates (ie claims development). The disclosure about claims development shall go back to the period when the earliest material claim arose for which there is still uncertainty about the amount and timing of the claims payments, but need not go back more than ten years. An insurer need not disclose this information for claims for which uncertainty about the amount and timing of claims payments is typically resolved within one year.

(d) the information about interest rate risk and credit risk that VAS on Financial Instruments would require if the insurance contracts were within the scope of the VAS.(e) Information about exposures to interest rate risk or market risk under embedded derivatives contained in a host insurance contract if the insurer is not required to, and does not, measure the embedded derivatives at fair value.